Executive Pay: Pseudo Science meets Reality

Amanda Wilson, CEO

10 October 2016

There has been much ado, in various directions, about the topic of executive pay lately, much of it plagued by inconsistencies, departures from previously held positions, and manifestly flawed logic leading to less than optimal outcomes for shareholders and executives. BHP’s CEO recently forgoing his bonus due to the Samarco tragedy – a move purportedly proposed by him – has been widely praised. Nonetheless such gestures often serve symbolism rather than substance. It could be argued that if Samarco was Mr McKenzie’s fault, he should no longer have a job at all. If it wasn't his fault (which seems plausible given he is relatively new to the job and certainly didn't establish the joint venture), trimming his pay risks looking churlish. It seems the board has gone for the latter, landing on it being a bit his fault so he gets to keep his job but with a costly slap on the wrist. Symbolism trumps logic for high-vis executive pay outcomes.

More recently several in the investor community have been expressing opposition to non-financial targets in executive remuneration plans, the purpose of which primarily rests on one or both of the following:

· Soft/non-financial targets are – or should be – lead indicators of longer term financial performance, and/or

· Linking them to incentives ensures they remain a focus for executives and signals their importance to a range of stakeholders including employees, customers and the community at large.

Opponents of softer measures point out that executives are in place at the behest of shareholders who expect them to produce returns and that including non-financial hurdles allows them to collect generous payments when they have not delivered financially. Quite justifiably, others note that looking after culture, diversity or customer satisfaction rightly fall under the remit of an executive’s day job, i.e. responsibility for these things is part and parcel of what they receive their often hefty fixed pay packets for, and it borders on brazen to carve them out as worthy of separate payments.

Most of these debates are set against a backdrop of clumsily articulated and variously felt levels of antagonism about executive pay quantum in general. This is further compounded by confusion as to what level of corporate performance can truly be attributed to executive efforts (an extensive study by Harvard’s McGahan and Porter suggests just 32 percent). There is also genuine divergence on investment time horizons and what rewarding for the long term constitutes. Many argue, quite simplistically, that to focus executives on the long term they should have ‘at risk’ remuneration either hurdled or deferred over long periods, e.g. up to 10 years. This has led to some posturing rather than rigorous advocacy – such as demanding that the then 87 year old CEO (now deceased) of a listed corporate defer his STI into shares. But more questionably it determines that the risks of the shareholder who can sell at any time should exactly parallel that of an executive who may have relocated his (or more rarely, her) family, and put his entire professional and personal reputation on the line.

At Regnan we have engaged extensively with companies for over 10 years on executive remuneration arguing that executive pay structure design should properly reflect the different nature and size of the risks undertaken by executives and long term investors. (We don’t believe it is possible, feasible or desirable to design remuneration structures for short term market players.) Executive pay should aim to be fit for purpose, as simple as possible, and should avoid allowing executives windfall gains in the event of unforeseen external tailwinds such as rising commodity prices and regulatory favour – but on the flip side it should not penalise for events genuinely outside of their control. We also argue that quantum matters – not because of contested views on inequality – but due to our (in our view sensible) belief that overpaying executives can corrupt succession planning, entrench barriers to the executive labour market, induce industrial disputation, and negatively affect an enterprise’s social licence to operate. We also argue that that the onus to demonstrate the necessity for incentives at all rests with boards, whom we find too often present the old trope “pay peanuts, you get monkeys”, notwithstanding our long held view that the best leaders are rarely motivated by money alone, and very few of them are genuinely required to act as entrepreneurs.

A pragmatic approach would be to pay executives simple and restrained packages that reflect their relative skills, competence and experience, while avoiding questionable approaches such as benchmarking based on market cap, with much of it delivered in deferred equity which provides a natural performance hurdle (upon which they have some but limited influence). And if, after a reasonable period of time, they are not held to be doing a good job for all stakeholders, they could lose their job, just the like the rest of us.

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